This is something that has been in the back of my mind over the past couple weeks, and I thought I would share a background of my reasoning and what I would like to do with the Pencils IRA Project. This is meant to be a fun and Foolish learning experience. I hope this is of interest to some -- if you have other ideas please share them here.

Background

There are not many investing services tailored to teens or young adults. Most of the services I have seen focus on helping parents start custodial accounts to manage investments for their kids, while some services offer methods to engage kids into a saving and investing mentality early on. Thankfully my father was very supportive of letting me invest my own funds and manage my custodial account independently, even though I started investing at the age of 12 years old.

However, as I graduated high school and entered Berea College, investing was no longer my prime focus. Most of my time was dedicated to other pursuits until my senior year at Berea (this year). I still owned a good deal of stocks, and sold some to cover expenses related to college, but I seldom looked at my portfolio or researched stocks as I went through college.

2012 brought a sudden turn of events for my family and me. My father unexpectedly passed away when I was 19 years old -- in between my sophomore and junior years of college -- which brought innumerable changes to my life. My father’s passing pushed me to take a deeper look into how I was managing all facets of my life. Investing wasn’t the first thing I evaluated, but in time I began asking myself the question: Is investing more than just a hobby for me? Of course, by now, you can probably guess the answer: yes.

My father had essentially managed all of our family’s finances, having started his own businesses, managing my parents’ IRA, supporting my investing interests, etc. He was my inspiration to get started with investing, and over the years he was the one who helped me figure out details like opening investing and bank accounts.

As I was drawn back into the world of investing after my father’s passing, I realized I had to transfer my custodial bank and investing accounts out of my father’s name into individual accounts under my name. Only, this time, I no longer had my father’s physical support and guidance as I went about this process. Not gonna lie, this was a challenge. A lot of kids may look forward to the day when a custodial account is finally transferred to their name, but for me it only served as a reminder that my father was really gone. I delayed the process. It took more than a year after my father’s death before I had the emotional stomach and motivation to transfer all these accounts into my own name.

Current developments

That brings us to today. As I dug deeper into the various options for investing accounts -- individual accounts, Traditional IRA, Roth IRA, SIMPLE IRA, and many more -- I realized that simply sticking with an individual account might not make the most sense for me. As much as I enjoy donating extra funds to the government through taxes, it’s nice to keep a little more of what I earned for myself.

To demonstrate my ignorance, I thought it was impossible to open an IRA until you had a full-time job. Even though I had been investing in stocks since I was 12 years old, I did not have a clue about managing individual investment funds in sensible and cost-effective accounts. To add to this dilemma, there are few (if any) resources specifically to help college students or young adults open retirement accounts. It’s as if there is a societal assumption that it is silly to even think about opening a retirement account until you have steady, full-time employment and/or have been married for a year or two. Wait until your mid-20s before you worry too much about the legal gobbledygook in the financial world. (Too bad if you have $29,400 in student loans -- the average debt of the Class of 2012 -- by the time you’re 22.)

I want to challenge this assumption. People who cultivate a saving mentality and save the majority of their income early on can afford to allocate funds to an IRA when they are 18 years old. This doesn’t necessarily mean that young adults can allocate the maximum contribution limit to an IRA from the very beginning, but even $500 or $1000 a year now is better than delaying an IRA for 3-5 years or however long it takes for the employment stars to align.

In short: starting an IRA early is feasible for anyone 18 years or older. As I finally learned throughout the course of my research, you can open an IRA today fairly painlessly. No upfront fees, little hassle, no minimum contribution amounts -- just get it done. IRAs are also helpful because they push investors to keep the bigger picture in mind and develop more discipline when making investing decisions. IRAs are long-term investment platforms which should be utilized at an early age.

Why a Roth IRA makes sense

My preference, especially for younger folks, is a Roth IRA. Roth’s are pretty simple: you are taxed on the money you contribute to a Roth in the present day but, so long as you follow the guidelines, down the road you are not taxed on funds you withdraw once you hit retirement age. For younger individuals, a Roth IRA is particularly beneficial if you invest in businesses that go on to crush the market’s returns over the long run. Beating the market over a long period of time and having the option to withdraw those funds tax-free further down the road sounds good to me.

With this in mind, I want to start the Pencils IRA Project.

The Pencils IRA Project is fairly simple. Each month, I will make a new investment within my Roth IRA. Ideally I will be able to contribute the maximum amount to the Roth ($5,500 this year), but the amount isn’t relevant for this project. I will contribute a regular amount of money to the Roth, whether it is $100 or $450 a month, and each month invest in a business that offers significant long-term potential to handily beat the market.

Criteria for Pencils IRA holdings

Here are the five necessities for the “mega-growers” to be added to this IRA portfolio:

Purpose-driven business. The company must be driven by a deeper purpose, e.g. Chipotle and Food With Integrity. If “financial profit” is the only answer to the question -- why does this company exist? -- it is time to move on.

Innovative products and services. Hand-in-hand with a purpose-driven business is the development and offering of innovative products and services. Businesses like Netflix, Chipotle, and Facebook are continually reshaping their respective fields. We want businesses with innovation in their DNA.

Visionary, experienced, involved leadership. We want leaders who think beyond the next quarter and short-term performance of a company’s stock, focusing instead on the long-term potential of a business. We want leaders capable of admitting when an error was made and redirecting course before further damage is done (e.g. Netflix’s Reed Hastings and Qwikster). We want business leaders who are personally invested in a business financially, ensuring their interests are aligned with fellow long-term stakeholders. We want leaders who either founded the business or have worked within the business for an extensive period of time while demonstrating their commitment to maintaining an innovative and adaptive company environment.

Consistently increasing cash flow production. The company must have a demonstrated record of consistent and increasing cash flow generation, preferably with positive free cash flow as well. This ensures that a company’s prospects are backed and validated by improving cash flow generation -- and overall improving financial performance -- each year.

Strong company culture. Each business must have a minimum rating from employees of 3.5/5 on Glassdoor. The CEO “approval rating” on Glassdoor must meet or exceed 70%. I’m interested in investing in visionary leaders who are also effective in inspiring others in the business to perform at their highest potential.

These five points, while seemingly simple, actually weed out quite a few businesses. It isn’t hard to tell that we are looking for innovative businesses, guided by visionary leadership, with a record of improving cash flow production over time. This doesn’t even mean that cash flow production must be outrageously huge, but I look for businesses that have managed to regularly increase their cash flow production over time. If a business has volatile cash flow production, it causes me to question the strength of the business and I usually move on to other opportunities.

Next steps

So there you have it. I am excited to test this strategy over time, because I see it as a way to experiment building a disciplined, very long-term focused IRA portfolio that can easily be tracked and modeled by other young investors (whether in age or young at heart). This is a small step to fill what seems to me to be a glaring void in investing education and services -- there are few resources that attempt to meaningfully address when and how young investors should utilize tools like IRAs. I hope this is a step in the right direction.

Each month I aim to invest in a business that fulfills the five attributes mentioned above. After each investment (which will have to be timed carefully so I do not violate TMF policies) I will provide a quick write-up detailing how the company meets these criteria. This provides for a simple and trackable long-term IRA portfolio of very promising businesses.

As always, your input, suggestions, and feedback are welcomed and appreciated. I should remind you that this is a personal project on my own volition and is not sanctioned or sponsored by the Fool.

The IRS will weep over our non-taxable gains in the coming decades. Here’s to Foolish investing for people of all ages!

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